Macro Strategy: A welcome but uncomfortable Sino-US trade truce

Risk appetite has returned this morning on the positive Sino-US trade truce struck at the G20 Summit. In currency markets, the Australian dollar gapped up to 84 from 83 against the Japanese yen. The offshore CNH opened strongly at 6.91 vs 6.95 last Friday. Futures are expecting US equity indices to open 1.7-2.0% higher today on top of last week’s 0.8% recovery fueled by Fed pause hopes. Emerging Asian currencies and stock markets are expected to cheer as well. Even so, watch for profit-taking risks on Tuesday. US financial markets will be closed on Wednesday to honor former US President George H.W. Bush.

There should be no wishful thinking that the truce would end the trade war between the world’s two largest economies. The White House has agreed not to raise tariffs on Chinese goods in the next 90 days in exchange for trade talks. This includes the scheduled increase in the tariff rate to 25% from 10% on USD200bn of Chinese goods from 1 January 2019. It, however, remains to be seen if real progress could be achieved during this narrow window to resolve the contentious issues, not just on trade, but also intellectual property rights. If negotiations fail by the early March 2019 deadline, the tariffs on USD200bn will rise to 25% alongside the threat for US tariffs on the remainder USD265bn worth of Chinese goods.

Apart from China, do pay attention to several speeches by key Fed officials this week – Vice Chairman Richard Clarida (3 Dec), Fed Governor Lael Brainard (3 Dec), New York Fed President John Williams (3-4 Dec) and Chairman James Powell’s testimony to the Joint Economic Committee (5 Dec). These speeches coupled with a fairly strong US nonfarm payrolls (200K consensus in November vs 246K in October) this Friday could dispel some of the speculation that the Fed is paving the ground for a pause. We believe that Powell has simply toned down his hawkish tilt seen in October, with the Fed on track to deliver a hike, the fourth this year, at the FOMC meeting on 19 December, as well as another four increases in 2019.

Rates: Trade war truce adds another tailwind to HY Asia govvies

HY Asia govvies (Indonesia, India and the Philippines), having had a substantial rally over the past two months, will get another boost when markets open today and reflect the trade war truce between the US and China. While there have been hints of a deal for a couple of weeks, an uncertainty premium has been lifted and this should be positive for all risky assets in the immediate term. Notably, this development builds on the collapse in oil prices (Brent crude prices are close to USD60/bbl compared to above USD85/bbl in early October) and perceived Fed dovishness (which drove 10Y UST yields below 3% last week).

While we agree that HY Asia govvies are likely to do well in the short term and that peak pain may already be behind us, we are a tad more cautious over the medium term. The rally since early October has been substantial. Compared to their recent peaks, 10Y yields in India, Indonesia and the Philippines have already fallen by 100bps, 60bps and 130bps respectively. As such, a large chunk of overvaluation (or risk premium) has already been flushed out of the system. Moreover, we think that the market (pricing in just one hike for 2019) may be underestimating the Fed. On balance, given the flatness of the INR, IDR and PHP govvie curves, we think that the front end may be more attractive than the back end from a risk-to-reward perspective.